TOBACCO TAX HIKE NO BOON TO LOW-PRICE LEADER B&W: BUYERS UNLIKELY TO TRADE DOWN TO VALUE END OF SMOKES SEGMENT

Cigarette prices will rise sharply with the taxes being proposed by the Clinton administration, but observers are divided on the marketing impact of a major hike -- potentially a near doubling of the cost per pack.

There are several proposals before Congress, including one that would raise the federal tax by $1.50 over two years. Although some people believe the final price increase will be much less, there is still little doubt a sizable increase is coming at the federal level, in addition to new taxes on cigarettes pending in all 50 states.

Jack Maxwell, industry analyst with Davenport & Co., Richmond, Va., said the conventional wisdom is that consumption declines 4% for every 10% price increase. Since most smokers are blue-collar workers who can "ill afford a price increase from $2 to $4," the likely result would be a sharp uptick in sales of value-price smokes.

When asked what cigarette marketer would win in that scenario, he said: "Nobody. They all go down the tubes."

NO BOON FOR B&W

And the biggest marketer of value-price brands doesn't expect any boom in sales.

Brown & Williamson Tobacco Corp., in an unusual display of candor, already has stated publicly that it would go down hardest and fastest. Chairman-CEO N.G. Brookes told the Senate Commerce Committee last month that B&W would be most severely affected because of its heavy reliance on value-price cigarette brands.

Mr. Brookes also said the industry deal with state attorneys general to restrict advertising and pay $368.5 billion over the next 25 years for healthcare costs would result in overall cigarette consumption declines of 33% and slice industry profits in half within five years.

B&W, with a 16% share of market, will suffer the most, he said, because its strongest business is low-price cigarettes and its profit margin is lower.

"The largest cigarette manufacturer [Philip Morris USA] has three times our domestic market share but six times our domestic operating income," Mr. Brookes said.

PRICE INCREASE WOULD BACKFIRE

Any attempt on B&W's part to raise prices beyond the tax hike would backfire since its niche is in the cheaper brands.

Moreover, he said proposed ad restrictions would hamper B&W's efforts to communicate its niche appeal.

"Since `Marlboro Friday' in 1993, discounting of premium brands has been an important strategy for our competitors," he said.

Mr. Maxwell's figures show that while B&W does lead the value-price segment, with a 33.7% share, R.J. Reynolds Tobacco Co. is right on its tail with a 32% share. Market leader Philip Morris has a 24.8% share.

Industry analysts said that with higher prices, a thriving black market will result.

EXPORT EXPLOSION

Manny Goldman, an analyst with PaineWebber, San Franciso, said that when a big price increase hit in Canada 10 years ago, the market fell from 46 billion cigarettes to 35 billion. But exports jumped from 2 billion to 10 billion, with much of that product coming back "under the table as imports -- from Toronto to Buffalo to Toronto," he said, "on which no domestic taxes were paid."

Gary Black, analyst at Sanford C. Bernstein & Co., said that even though it will be tough for smokers to afford cigarettes after a big tax increase, sales of value brands won't outpace those of full-price brands.

Tobacco-only stores, dependent on cigarettes for all their profit, will probably reduce their markup to the 8% to 10% range from a current 22%, he said, to keep customers coming in. That will benefit full-price brands.

Wholesaler consolidation, already rife, also should increase as profit margins grow thinner. A wholesaler in Washington state said that in his market distributors have already gone from 30 in 1973 to 18 currently.

"We'll just have to ride out this next storm," he said.

The National Association of Convenience Stores sees the major problem with a big price boost as theft.

"It's fundamentally a crime problem," said a lobbyist for the group.

As a cigarette carton's price rises from $20 to $35, he said, "the product could be worth more than the cash in the register."

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Judann Pollack

Judann Pollack (Judy) is deputy editor of Ad Age. She joined Ad Age in 1985 as editorial assistant, along the way fielding pretty much every position on the masthead, including reporter, Chicago bureau chief, New York bureau chief, features editor, executive editor and managing editor-international.